Are mutual funds worth a look right now? Definitely! But thats what mutual funds have you believe. What do you the investor feel about it? For investors who are still a little confused about the issue, we have tried to clear the cobwebs.
Investors who have historically been choosing the dividend plan in their mutual fund investments, the budget has dealt a painful blow. Earlier dividends were tax-free in the hands of investors (funds paid a dividend distribution tax). With the latest budgetary recommendations, dividends from income funds will now be taxed (after deduction of tax at source) in the hands of the investor at the tax rate applicable to him. Dividends from equity funds will taxed in the hands of the investor at a flat rate of 10%.
How is the decision to tax dividends going to affect you?
If you are in the highest tax bracket, then the move to tax dividends is going to affect you the most vis-୶is investors in lower brackets. (Income funds over here includes gilt funds, debt funds, liquid funds). A large section of the investment community opting for the dividend option is in the highest tax bracket (perhaps this is what prompted the move to tax dividends apart from the fact that the finance minister had made dividends tax free for only 3 years and this moratorium was supposed to go in 2003 in any case)
Mr Sarvana Kumar (Head Fixed Income, SBI MF) reveals, More than 90% inflow into liquid funds as well as more than 60% inflow into income funds as well as gilt funds comes from corporates as well as HNIs (high networth individuals). To a large extent this section of the investment community is not really sensitive to having their dividends being subjected to a higher tax rate. However, even Mr Kumar admits, Our expectation is that, to some extent the inflow into mutual fund industry may be affected by the recent move.
So what should you do?
The easiest option is to switch to the growth plan from the dividend plan. If you are with the fund for more than a year, you then become eligible for long-term capital gains/loss on exit. If you exit the fund before 12 months in the growth option, you will become eligible for short-term capital gains/loss at the tax bracket applicable to you.
Another option worth a look is the systematic withdrawal plan. This plan allows the investor to receive post-dated cheques of a pre-determined amount (similar to the systematic investment plan, only difference is this is withdrawal). For investors who have been with the fund for over a year, the SWP will be eligible for long-term capital gains/loss. This option is particularly handy for investors who would like a steady income stream, like senior citizens who have invested in the dividend plans of MIPs (monthly income plans) but would now like to switch.
Are fixed deposits more attractive vis-୶is mutual funds?
Mutual funds are and will always remain more attractive because of the liquidity that they provide. This is something fixed deposits (FDs) can never really provide, at least not on a comparable level to mutual funds.
As far as returns go, FDs over a year carry an interest rate of 8-8.5%. This compares poorly with returns on income/gilt funds (growth option) that have exceeded 20% (in some cases) over the last year. However, the dividend option of mutual fund schemes compares unfavourably with (bank/housing finance company)FDs given the 80L benefit available to them. Leading income funds have been declaring annualized dividends in the range of 10-11%. Post-tax for an investor in the highest tax bracket, that leaves him with a pittance.
Broadly these are the options available to the mutual fund investor going forward. To answer the question we raised in our opening lines - Are mutual funds worth a look right now? Definitely!
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